Hedge Fund Tax Changes Cause Indigestion in Greenwich

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The steaks and expensive Cabernet weren't going down so well at a private dinner in Greenwich last week, as 30 private-equity and hedge-fund managers tried to digest the implications of looming federal tax laws that could slash their take-home pay and force them to return money to investors.

Mark Lange of McKenna Long & Aldrige held the captive attention of over 30 fund executives that included heavyweights from JPMorgan’s Highbridge Energy, $6 billion private-equity firm Scions Capital, mutual fund Kinetics Asset Management, and the $100 billion-plus administrator of finance firms GlobalOp Financial Services.

"I think some guys left the room wanting to chuck the fine wine they’d just been served," said one hedge-fund lawyer who attended the private event at the Innis Arden Golf Club in Old Greenwich.

It wasn't the food or the wine: It's the uncertainty. The House has passed a bill that would treat carried interest — the share of a fund's income that is distributed to managers — like regular income, taxing it at far higher rates. The bill is currently with the Senate, which will probably water down that measure, but no one, including the the financiers of Greenwich, knows by how much.

The consequences could be ugly. If firms raised new money that they expected to book as carried-interest income down the road, they may need to beg their investors to restructure how they get paid or give them back their investment at a discount to promised returns. That's anathema to fund managers. Almost as bad is the idea of forgoing fat management fees, but that's exactly what Lange has been telling funds they might need to do in order to suck up to investors who would have to approve a payout revamp.

New investors don’t have a lot of incentive to play ball, so they might need to fork over more coin to accountants and lawyers for a creative workaround to the coming tax hike. In the end someone, somewhere will make money from the chaos.

The dinner was designed as a reality check for the big money managers: We don't know how much of your compensation Washington is going after, but you're going to take a hit. It was also a way to rally the industry's muscle for a Hail Mary lobbying effort to minimize the damage.

"Don't count out the power of the private-equity lobby," Lange said.

A rescue could come in the form of a counter tax break by Connecticut governor Jodi Rell, who is already mounting a campaign to lessen the pain of any funds who are tempted to leave New York and park their business along her gold coast. (The New York legislature dropped the idea of charging its own carried interest tax on Tuesday; hedge funds are still planning on attending an "intimate" dinner with Rell.)

But the sweet spot of making enormous profits off dealmaking built around clever tax structures is clearly evaporating.

“For the first time, fund managers are finally feeling the inevitable political heat that has a full-on frontal attack to the way they make money. They won’t give up without a heavy lobbying fight, but I sense they know the end is near,” Lange said.

That's enough to make any hedge fund manager lose his appetite.